Reception will improve for satellite radio

By TheStreet.com

Four months ago, I made my first foray into the debate over which is better: Sirius Satellite Radio (SIRI, news, msgs) or XM Satellite Radio (XMSR, news, msgs). Some people agreed with my argument that Sirius was being punished for XM's missteps and others castigating my analysis as ignorant and uninformed.

In the stock market, time settles all disputes. XM's share price was cut in half, falling to below $10, though it has recently recovered to about $12, giving it a decline of roughly 40% since late April. Sirius fell back below $4, but has bounced back above that level, giving it a drop of only about 10%.

Nonetheless, I believe the worst is over for the industry and that it is approaching critical mass. A holiday season sales bump is at hand and both companies should turn cash-flow positive in the fourth-quarter and for all of 2007. With the stocks near their lows, we have a compelling picture for the patient investor.

XM was disgorged over the past four months by many fund managers who felt (so typically) that management had lost all credibility after twice lowering guidance on subscriber numbers with its net new subscriber counts lagging behind Sirius'. Twice since then, XM has lowered its full-year goals from 9 million total subscribers by the end of the year to 8.5 million, and more recently to a range of between 7.7 million and 8.2 million. This was alarming, given that XM offers Major League Baseball -- it apparently wasn't meeting its targets for signing up subscribers during the prime season for that sport.

As XM struggled, Sirius continued to execute its plan for this year, outpacing XM in new subscribers in the first two quarters. Its target for the year is to add 1.7 million new subscribers in the second half and 3 million net for the full year to end 2006 with a total of 6.3 million

The year-end holiday selling season is the biggest of the year, and satellite radio makes for a great gift. It's a gift that keeps on giving.

Last year, Howard Stern was still under contract to CBS and Sirius was somewhat limited in its ability to use him as a marketing tool at the end of the year. The good news was that Stern was news and Sirius got plenty of free publicity about his impending arrival anyway.

In 2006, Sirius is in a position to undertake a much stronger holiday marketing campaign. In addition to the shock jock, Sirius is likely to promote its new Catholic Channel to its natural constituency of 65 million Americans. Also, Nascar will be moving from XM to Sirius near the end of the year giving Sirius a chance to make inroads among 75 million devoted race car fans.

XM tries to put its house in order

Nate Davis has moved from XM's board, where he has been since 1999, to the position of COO, which was formerly held by CEO Hugh Panero. He's a tough guy who should know how to straighten out XM's problems.

In late August, the FCC approved three XM radio models that solve the frequency interference issues with terrestrial radio that forced it to halt sales of eight of its models. That approval is important for improving sales growth during the holidays.

A recent positive report from Bear Stearns lifted the stock from its low, under $10 price and caused something of a short squeeze, pushing XM rapidly toward $13 in just a couple of days. It has stalled there, awaiting additional good news.

Satellite radio is still in its infancy. When these stocks peaked in December 2004 at $40 for XM and over $9 for Sirius, the industry had a total subscriber count of only 4 million. Now, just two years later, expectations are that the pair will end 2006 with more than 14 million subscribers total.

There are about 225 million cars on the road in the United States. Sixteen million new ones are purchased every year, so auto penetration is only about 6% at the moment. Growth lies ahead as more and more car manufacturers build satellite radios into their new models as they come down the production lines. Also, people like the product and are starting to buy it for their homes or receive it encrypted via the Internet in their offices.

Positive cash flow is near

The heavy lifting that was required to launch this industry is done and the industry is nearing the point of critical mass, positive cash flow and, someday, even earnings. Both companies have projected positive cash flow for the fourth quarter, although XM's latest projections waffled on this issue if sales come in at the low end of the projected range. One would hope that XM has low-balled numbers now so that it can beat them at the end of the year. Both companies have also projected positive cash flow for 2007, although probably not for every quarter.

The trend is in the right direction. Industry conditions are improving, and the cost of receivers has declined with production efficiencies, yet both stocks are in the doghouse. It's a much better picture for patient investors than the one that prevailed two years ago when the stocks were vastly higher and the industry was still tiny and unproven.

Also, remember that many institutional investors will not or may not purchase stocks selling for less than $5. As Sirius nears that price point again, if it continues to execute well, expect to see some new buyers of size materialize.

Once XM demonstrates that it can execute its business plan, it will move higher, too. Right now it has to satisfy the "show me" camp.

By Joan Lappin for TheStreet.com

At the time of publication, Lappin's firm was long Sirius, although holdings can change at any time. Joan Lappin, CFA, is chair and chief investment officer of Gramercy Capital Management Corp., a registered investment advisor based in New York City, which she founded in 1986. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Lappin appreciates your feedback; click here to send her an email.